Interphase (INPH) 10-Q 2007 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

OR

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

  For the transition period from                      to                                           

Commission File Number 0-13071
 

INTERPHASE CORPORATION

(Exact name of registrant as specified in its charter)

 

Texas	75-1549797
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

Parkway Centre I
2901 North Dallas Parkway, Suite 200
Plano, Texas 75093
(Address of Principal Executive Offices and Zip Code)

 

(214) 654-5000
(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ          No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  o                           Accelerated filer  o                      Non-accelerated filer  þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yeso       Noþ

As of November 5, 2007, shares of common stock outstanding totaled 6,334,972.

INTERPHASE CORPORATION

Index to Form 10-Q
Quarterly Period Ended September 30, 2007

Part I — Financial Information
Item 1.	Condensed Consolidated Financial Statements (unaudited)
	Condensed Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006	2
	Condensed Consolidated Statements of Operations for the three months and nine months ended September 30, 2007 and 2006	3
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006	4
	Notes to Condensed Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	14
Item 4.	Controls and Procedures	15
Part II — Other Information
Item 1.	Legal Proceedings	15
Item 1A.	Risk Factors	15
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	15
Item 3.	Defaults Upon Senior Securities	15
Item 4.	Submission of Matters to a Vote of Security Holders	16
Item 5.	Other Information	16
Item 6.	Exhibits	16
Rule 13a-14(a)/15d-14(a) Certification
Rule 13a-14(a)/15d-14(a) Certification
Section 1350 Certification
Section 1350 Certification

PART I
FINANCIAL INFORMATION

Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

INTERPHASE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)

	September 30,			December 31,
ASSETS	2007			2006
Cash and cash equivalents	$	5,446		$	9,061
Marketable securities		14,430			13,469
Trade accounts receivable, less allowances of $167 and $118, respectively		7,189			5,824
Inventories		2,452			1,921
Prepaid expenses and other current assets		1,776			1,298
Total current assets		31,293			31,573
Machinery and equipment		6,577			6,308
Leasehold improvements		424			422
Furniture and fixtures		568			554
		7,569			7,284
Less-accumulated depreciation and amortization		(6,713	)		(6,308	)
Total property and equipment, net		856			976
Capitalized software, net		2,062			1,322
Other assets		204			191
Total assets	$	34,415		$	34,062
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Accounts payable	$	1,686		$	1,372
Deferred revenue		44			98
Accrued liabilities		1,261			1,140
Accrued compensation		1,707			2,067
Total current liabilities		4,698			4,677
Deferred lease obligations		60			85
Long-term debt		3,500			3,500
Total liabilities		8,258			8,262
Commitments and Contingencies
Shareholders’ Equity
Common stock, $0.10 par value; 100,000,000 shares authorized; 6,281,373 and 6,152,141 shares issued and outstanding, respectively		628			615
Additional paid in capital		40,867			39,884
Retained deficit		(14,774	)		(14,059	)
Cumulative other comprehensive loss		(564	)		(640	)
Total shareholders’ equity		26,157			25,800
Total liabilities and shareholders’ equity	$	34,415		$	34,062

The accompanying notes are an integral part of these condensed consolidated financial statements.

2

INTERPHASE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2007			2006			2007			2006
Revenues	$	8,429		$	7,758		$	21,774		$	25,280
Cost of sales		3,249			3,691			8,970			11,692
Gross margin		5,180			4,067			12,804			13,588
Research and development		2,413			2,019			7,320			5,865
Sales and marketing		1,417			1,222			4,208			4,040
General and administrative		1,180			851			3,267			3,047
Total operating expenses		5,010			4,092			14,795			12,952
Income (loss) from operations		170			(25	)		(1,991	)		636
Interest income, net		185			189			578			429
Other income (loss), net		192			(46	)		349			314
Income (loss) before income tax		547			118			(1,064	)		1,379
Income tax benefit		(151	)		(57	)		(300	)		(249	)
Net income (loss)	$	698		$	175		$	(764	)	$	1,628
Net income (loss) per share:
Basic EPS	$	0.11		$	0.03		$	(0.13	)	$	0.28
Diluted EPS	$	0.10		$	0.03		$	(0.13	)	$	0.27
Weighted average common shares		6,152			5,857			6,112			5,832
Weighted average common and dilutive shares		6,781			6,330			6,112			6,105

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

INTERPHASE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

	Nine Months Ended
	September 30,
	2007			2006
Cash flows from operating activities:
Net (loss) income	$	(764	)	$	1,628
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Provision for uncollectible accounts and returns		49			23
Provision for excess and obsolete inventories		300			400
Depreciation and amortization		665			491
Amortization of restricted stock		261			211
Change in assets and liabilities:
Trade accounts receivable		(1,414	)		(365	)
Inventories		(831	)		352
Prepaid expenses and other current assets		(356	)		(81	)
Other assets		(3	)		1
Accounts payable, deferred revenue and accrued liabilities		367			(148	)
Accrued compensation		(441	)		902
Other non-current liabilities		—			(34	)
Deferred lease obligations		(25	)		(4	)
Net cash (used in) provided by operating activities		(2,192	)		3,376
Cash flows from investing activities:
Purchase of property and equipment		(310	)		(129	)
Purchase of capitalized software		(866	)		(505	)
Proceeds from the sale of marketable securities		11,522			11,681
Purchase of marketable securities		(12,430	)		(10,278	)
Net cash (used in) provided by investing activities		(2,084	)		769
Cash flows from financing activities:
Proceeds from the exercise of stock options		735			392
Net cash provided by financing activities		735			392
Effect of exchange rate changes on cash and cash equivalents		(74	)		71
Net (decrease) increase in cash and cash equivalents		(3,615	)		4,608
Cash and cash equivalents at beginning of period		9,061			3,180
Cash and cash equivalents at end of period	$	5,446		$	7,788

The accompanying notes are an integral part of these condensed consolidated financial statements.

4

INTERPAHSE CORPORATION

NOTES CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1. — BASIS OF PRESENTATION

Interphase Corporation and subsidiaries (“Interphase” or the “Company”) provide robust building blocks, highly integrated subsystems and innovative gateway appliances for the converged communications network. Building on a 30-year history of providing advanced Input/Output (I/O) solutions for telecommunications and enterprise applications, and addressing the need for high speed connectivity, Interphase has established a key role in delivering next generation AdvancedTCA^® (Advanced Telecommunications Computing Architecture or ATCA), MicroTCA and AdvancedMC™ (Advanced Mezzanine Card or AMC) solutions to the marketplace. The Company’s products enable telecommunications equipment manufacturers to deploy robust and highly scalable network infrastructure equipment into Third Generation Wireless (3G), IP Multimedia Subsystem (IMS), Voice over IP (VoIP) and Broadband Access Networks worldwide, enabling the delivery of advanced IPTV and Triple Play services. See Note 9 for information regarding the Company’s revenues related to North America and foreign countries.

The accompanying condensed consolidated financial statements include the accounts of Interphase Corporation and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated. While the accompanying condensed consolidated financial statements are unaudited, they have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of the Company, all material standard adjustments and disclosures necessary to fairly present the results of such periods have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. Operating results for the three months and nine months ended September 30, 2007, are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.  Certain prior period amounts on the cash flow statement and in Note 9 have been reclassified to conform with current period classifications. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2006.

NOTE 2. — STOCK-BASED COMPENSATION

The Company accounts for stock-based compensation in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payments.” The Company had no unvested stock options nor were any stock options granted during 2007 or 2006, and as a result the Company recorded no stock-based compensation expense related to stock options during 2007 or 2006.

The following table summarizes stock option activity under the Company’s stock option plans (number of options in thousands):

	Number of			Weighted Average
	Options			Option Price
Balance, December 31, 2006		2,122			9.52
Granted		—			—
Exercised		(99	)		7.39
Cancelled		(3	)		20.38
Balance, September 30, 2007		2,020			9.61

The Interphase Corporation 2004 Long-Term Stock Incentive Plan provides for grants of bonus stock awards (“restricted stock”) to its directors and certain employees at no cost to the recipient. Holders of restricted stock are entitled to cash dividends, if any, and to vote their respective shares. Restrictions limit the sale or transfer of these shares during a predefined vesting period, currently ranging from three to four years, and in some cases is subject to the achievement of certain performance conditions. During the nine months ended September 30, 2007, there were 106,000 shares granted at the market price of $10.94. Upon issuance of restricted stock under the plan,

5

INTERPAHSE CORPORATION
NOTES CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

unearned compensation equivalent to the market value at the date of grant is recorded as a reduction to shareholders’ equity and subsequently amortized to expense over the respective restriction periods. Compensation expense related to restricted stock was approximately $88,000 and $32,000 for the three months ended September 30, 2007 and 2006, respectively. Compensation expense related to restricted stock was approximately $261,000 and $211,000 for the nine months ended September 30, 2007 and 2006, respectively. As of September 30, 2007, there is approximately $1.5 million of total unamortized compensation expense related to unvested restricted stock remaining to be recognized. The following summarizes the restricted stock activity for the nine months ended September 30, 2007:

	Restricted Stock			Weighted Average
	Shares			Grant Date Value
Nonvested restricted stock at December 31, 2006		221,425			5.96
Granted		106,000			10.94
Vested		(38,455	)		5.76
Cancelled/Forefeited		(76,250	)		6.01
Nonvested restricted stock at September 30, 2007		212,720			8.52

NOTE 3. — INVENTORIES

Inventories are valued at the lower of cost or market and include material, labor and manufacturing overhead. Cost is determined on a first-in, first-out basis (in thousands):

	September 30, 2007		December 31, 2006
Raw materials	$	1,854	$	1,449
Work-in-process		470		344
Finished goods		128		128
Total	$	2,452	$	1,921

Valuing inventory at the lower of cost or market involves an inherent level of risk and uncertainty due to technology trends in the industry and customer demand for the Company’s products. Future events may cause significant fluctuations in the Company’s operating results. Inventories are written down when needed to ensure the Company carries inventory at the lower of cost or market. Writedowns for the three months ended September 30, 2007 and 2006 were $100,000 and $100,000, respectively. Writedowns for the nine months ended September 30, 2007 and 2006 were $300,000 and $400,000, respectively.

NOTE 4. — DERIVATIVE FINANCIAL INSTRUMENTS

The Company is exposed to adverse movements in foreign currency exchange rates because it conducts business on a global basis and in some cases in foreign currencies. The Company’s operations in France are transacted in the local currency and converted into U.S. Dollars based on published exchange rates for the periods reported and are therefore subject to risk of exchange rate fluctuations.

In an attempt to mitigate the risk described above, the Company may enter into, from time to time, foreign exchange contracts to purchase a fixed amount of Euros on a fixed date in the future at a fixed rate determined at the contract date.  These derivative financial instruments do not meet the criteria to qualify as hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and therefore, any changes in the market value of these contracts are recognized as a gain or loss in the period of the change.  For the three months and nine months ended September 30, 2007, the Company recognized a gain of approximately $187,000 and $306,000 respectively related to these foreign exchange contracts. For the three months ended September 30, 2006 the Company recognized a loss of approximately $55,000 and for the nine months ended September 30, 2006, the Company recognized a gain of approximately $294,000 related to these foreign exchange contracts. At September 30, 2007, the Company had two foreign exchange contracts outstanding to acquire 1.1 million Euros for each

6

INTERPAHSE CORPORATION
NOTES CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

contract on specified dates during the next four months. At September 30, 2007, the Company carried an approximately $241,000 asset on the balance sheet, classified in prepaid expenses and other current assets, related to the fair value of its outstanding foreign exchange contracts. There were three such contracts outstanding at December 31, 2006 classified as a $185,000 asset on the balance sheet and included in prepaid expenses and other current assets.

NOTE 5. — INCOME TAXES

SFAS No. 109, “Accounting for Income Taxes,” requires that a valuation allowance be established when it is “more likely than not” that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence needs to be considered, including a company’s current and past performance, the market environment in which the company operates, the utilization of past tax credits, length of carry back and carry forward periods, existing contracts or sales backlog that will result in future profits, as well as other factors.

Forming a conclusion on a valuation allowance is difficult when there is negative evidence such as cumulative losses in recent years. Cumulative losses weigh heavily in the overall assessment. As a result of a review undertaken at December 31, 2002, the Company concluded that it was appropriate to establish a full valuation allowance for its net deferred tax assets. Until an appropriate level of profitability is sustained, the Company expects to continue to record a full valuation allowance on future tax benefits except for those that may be generated in foreign jurisdictions.

The effective tax rate differed from the U.S. statutory rate as the Company continued to provide a full valuation allowance for its net deferred tax assets at September 30, 2007 and September 30, 2006. During the three and nine months ended September 30, 2007 and September 30, 2006, the Company recorded a tax benefit related to its operations in France. This benefit was primarily the result of a 10% research and development tax credit.

The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), on January 1, 2007. At September 30, 2007, the Company had an uncertain U.S. tax position of approximately $80,000 related to foreign operations. Due to the net operating loss position in the U.S., the Company would not incur tax, interest or penalty currently or in the near future. As such, no adjustment was made to equity and there is no impact on the Company’s effective tax rate. The Company does not anticipate any event in the next twelve months that would cause a change to this position. The Company will recognize any penalties and interest when necessary as tax expense. The U.S. federal returns for the years ending December 31, 2003 and after are open for IRS examination. The Company’s operations during the year ended December 31, 2002 generated a loss, and the 2002 net operating loss (NOL) is still being used by the Company. The IRS may audit up to the NOL amount generated during the year ended December 31, 2002 until the expiration of the statute of limitations for open tax years.

The Company is also subject to income tax in France. At September 30, 2007, the Company had an uncertain tax position of approximately $238,000 of which $222,000 is related to a potential tax liability, $12,000 is related to possible interest, and $4,000 is related to a potential penalty. During the six months since March 31, 2007, approximately $38,000 of this uncertain tax position was accounted for as a reduction to income tax benefit. Prior to March 31, 2007, this position had been accounted for as a reduction in shareholders’ equity. The uncertain tax position in France is expected to have a favorable impact in the amount of $222,000, resulting in a favorable impact on the effective tax rate. The Company does not anticipate any event in the next twelve months that would cause a change to this position. The French income tax returns for the years ended December 31, 2004 and subsequent remain open for examination.

NOTE 6. — CREDIT FACILITY

The Company maintains a $5.0 million revolving bank credit facility with a maturity date of July 31, 2009 and interest rate of LIBOR plus 1.0% (6.25% at September 30, 2007). All borrowings under this facility are secured by marketable securities. The borrowings of $3.5 million are classified as long-term debt on the accompanying balance sheets.

7

INTERPAHSE CORPORATION
NOTES CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 7. — COMPREHENSIVE INCOME (LOSS)

The following table shows the Company’s comprehensive income (loss) (in thousands):

	Three months ended						Nine months ended
	September 30,						September 30,
	2007			2006			2007			2006
Net income (loss)	$	698		$	175		$	(764	)	$	1,628
Other comprehensive income (loss):
Unrealized holding gain arising during period, net of tax		57			43			53			49
Foreign currency translation adjustment		(1	)		(18	)		23			36
Comprehensive income (loss)	$	754		$	200		$	(688	)	$	1,713

NOTE 8. — EARNINGS PER SHARE

Basic earnings per share are computed by dividing reported earnings available to common shareholders by weighted average common shares outstanding.  Diluted earnings per share give effect to dilutive potential common shares.  Earnings per share are calculated as follows (in thousands, except per share data):

	Three months ended				Nine months ended
	September 30,				September 30,
	2007		2006		2007			2006
Basic earnings per share:
Net income (loss)	$	698	$	175	$	(764	)	$	1,628
Weighted average common shares outstanding		6,152		5,857		6,112			5,832
Basic earnings (loss) per share	$	0.11	$	0.03	$	(0.13	)	$	0.28
Diluted earnings per share:
Net income (loss)	$	698	$	175	$	(764	)	$	1,628
Weighted average common shares outstanding		6,152		5,857		6,112			5,832
Dilutive stock options and restricted stock		629		473		—			273
Weighted average common shares outstanding – assuming dilution		6,781		6,330		6,112			6,105
Diluted earnings (loss) per share	$	0.10	$	0.03	$	(0.13	)	$	0.27
Outstanding stock options and unvested restricted stock that were not included in the diluted calculation because their effect would be anti-dilutive		755		813		1,458			1,389

NOTE 9. — SEGMENT INFORMATION

The Company is principally engaged in the design, development, and manufacturing of high-performance connectivity products utilizing advanced technologies being used in next generation telecommunication networks and enterprise data networks. Except for revenue performance, which is monitored by product line, the chief operating decision-makers review financial information presented on a consolidated basis for purposes of making

8

INTERPAHSE CORPORATION
NOTES CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

operating decisions and assessing financial performance. Accordingly, the Company considers itself to be in a single industry segment.

Geographic revenues related to North America and foreign countries is as follows (in thousands):

	Three months ended				Nine months ended
	September 30,				September 30,
	2007		2006		2007		2006
Revenues:
North America	$	3,672	$	2,495	$	9,572	$	9,007
Europe		1,514		3,857		2,253		10,795
Pacific Rim		3,243		1,406		9,949		5,478
Total	$	8,429	$	7,758	$	21,774	$	25,280

Additional information regarding revenues by product-line is as follows (in thousands):

	Three months ended				Nine months ended
	September 30,				September 30,
	2007		2006		2007		2006
Product Revenues:
Broadband telecom	$	7,170	$	6,300	$	18,420	$	20,155
Enterprise		980		1,302		2,402		3,845
Professional services		124		—		382		123
Other		155		156		570		1,157
Total	$	8,429	$	7,758	$	21,774	$	25,280

9

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements about the business, financial condition and prospects of the Company. These statements are made under the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. The actual results of the Company could differ materially from those indicated by the forward-looking statements because of various risks and uncertainties, including without limitation, our reliance on a limited number of customers, failure to see spending improvements in the telecommunications and computer networking industries, significant changes in product demand, the availability of products, changes in competition, various inventory risks due to changes in market conditions and other risks and uncertainties indicated in the Company’s filings and reports with the Securities and Exchange Commission. All the foregoing risks and uncertainties are beyond the ability of the Company to control, and in many cases, the Company cannot predict the risks and uncertainties that could cause its actual results to differ materially from those indicated by the forward-looking statements. When used in this report, the words “believes”, “plans”, “expects”, “intends”, and “anticipates” and similar expressions as they relate to the Company or its management are intended to identify forward-looking statements.

RESULTS OF OPERATIONS

Revenue

Total revenue increased to $8.4 million for the three months ended September 30, 2007, compared to $7.8 million for the same period in the prior year. The increase was primarily attributable to broadband telecom revenue, which increased approximately 14% to $7.2 million for the three months ended September 30, 2007, compared to $6.3 million in the comparable period in the prior year. Partially offsetting the broadband telecom revenue increase was an expected decrease in enterprise revenue to $980,000 for the three months ended September 30, 2007, compared to $1.3 million for the same period in the prior year. All other revenues, increased slightly to $279,000 for the three months ended September 30, 2007, compared to $156,000 for the same period in the prior year.

During the third quarter of 2007, sales to two customers individually accounted for approximately 28% and 26% of total revenues, respectively. During the third quarter of 2006, sales to five customers individually accounted for approximately 24%, 16%, 15%, 14% and 11% of total revenues, respectively. No other customer accounted for more than 10% of our consolidated revenue in the periods presented.

Total revenue decreased to $21.8 million for the nine months ended September 30, 2007, compared to $25.3 million in the comparable period for the prior year. The decrease in revenue is primarily attributable to broadband telecom product revenue which decreased 9% to $18.4 million for the nine months ended September 30, 2007 compared to $20.2 million for the same period in the prior year. The decrease in broadband telecom revenues was primarily due to a significant reduction in revenues during the first quarter of 2007 due to the general telecommunications market slowdown as well as the merger activity related slowdown experienced in the businesses of our top Tier 1 customers. In addition to the broadband telecom revenue decrease, enterprise revenue decreased to $2.4 million for the nine months ended September 30, 2007, compared to $3.8 million for the same period in the previous year. All other revenues decreased to $952,000 for the nine months ended September 30, 2007 from $1.2 million for the nine months ended September 30, 2006. Included in all other revenues for the nine months ended September 30, 2006 was approximately $400,000 of raw material parts, sold at cost, which reduced our exposure to potential excess and obsolete inventory charges.

Gross Margin

For the three months ended September 30, 2007, gross margin as a percentage of sales was 61% compared to 52% for the same period in the prior year. The increase in our gross margin percentage in the third quarter of 2007 was due to a revenue mix shift toward higher margin products and more efficient operations.

Gross margin as a percentage of sales was 59% and 54% for the nine months ended September 30, 2007 and 2006, respectively. The increase in gross margin was primarily a result of a shift in revenue mix toward higher margin products. Additionally, the 2006 margin was negatively impacted by the sale of approximately $400,000 of raw materials at cost in the first quarter of 2006. Finally, for the nine months ended September 30, 2007, we recorded

10

$100,000 less in obsolete inventory charges compared to the nine months ended September 30, 2006. The effects of the three factors described above were partially offset by reduced utilization of our manufacturing facility. We believe that pricing pressures in the industry will likely dampen gross margin in future periods and it may become increasingly challenging to offset these pressures with incremental supplier cost reductions and factory productivity improvements.

Research and Development

Our investment in the development of new products through research and development was $2.4 million and $2.0 million for the three months ended September 30, 2007 and 2006. The increase in research and development expense is primarily due to our continued investment in the area of project related research and development activities primarily on a variable basis as we continue to prepare for several new product introductions and field trials scheduled for later in 2007 and 2008. As a percentage of total revenue, research and development expense was approximately 29% in the third quarter of 2007 as compared to approximately 26% for the same period for the prior year. The increase in research and development costs as a percentage of total revenue is due to research and development expense increasing at a higher rate than revenue. We anticipate that spending on research and development will increase slightly in the near future, subject to fluctuations in currency exchange rates because much of our research and development expense is associated with our engineering lab in France (see Item 3 – Foreign Currency Risk).

Our investment in the development of new products through research and development was $7.3 million and $5.9 million for the nine months ended September 30, 2007 and 2006, respectively. The increase in research and development expense is primarily due to our investment throughout 2007 in the area of project related research and development activities primarily on a variable basis. As a percentage of total revenue, research and development expense was approximately 34% for the nine months ended September 30, 2007 and 23% for the nine months ended September 30, 2006. The increase in research and development expense as a percentage of total revenue is due to research and development expense increasing while revenue decreased.

Sales and Marketing

Sales and marketing expenses were $1.4 million and $1.2 million for the three months ended September 30, 2007 and 2006, respectively. The increase in sales and marketing expense is primarily due to additional headcount in Europe in 2007 as we seek to expand our market reach on a global basis. Additionally there is higher variable compensation expense in 2007 compared to the same period in 2006 due to the increase in revenues. As a percentage of total revenue, sales and marketing expense was approximately 17% for the third quarter of 2007 and 16% for the third quarter of 2006. The increase in sales and marketing costs as a percentage of total revenue is due to sales and marketing expense increasing at a higher rate than revenue. We will continue to monitor the level of sales and marketing costs concurrently with actual revenue and profit results.

Sales and marketing expenses were $4.2 million and $4.0 million for the nine months ended September 30, 2007 and 2006, respectively. The increase in sales and marketing expense is primarily due to additional headcount in 2007. As a percentage of total revenue, sales and marketing expense was approximately 19% for the nine months ended September 30, 2007 and 16% for the nine months ended September 30, 2006. The increase in sales and marketing expense as a percentage of total revenue is due to sales and marketing expense increasing while revenue decreased.

General and Administrative

General and administrative expenses were $1.2 million and $900,000 for the three months ended September 30, 2007 and 2006, respectively. The increase in general and administrative expense period over period primarily relates to support costs and amortization expense related to our new Enterprise Management System installed in the second quarter of 2007. Additionally, we have been using outside services as part of our first year management assessment for Sarbanes-Oxley Section 404 compliance. As a percentage of total revenue, general and administrative expenses were approximately 14% in the third quarter of 2007 and 11% for the same period in the prior year. The increase as a percentage of revenue is due to general and administrative expenses increasing at a higher rate than revenue. We will continue to monitor the level of general and administrative expenses concurrently with actual revenue and profit results.

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General and administrative expenses were $3.3 million and $3.0 million for the nine months ended September 30, 2007 and 2006, respectively. The increase in general and administrative expense period over period primarily relates to support costs and amortization expense related to our new Enterprise Management System installed in the second quarter of 2007. Additionally, we have been using outside services as part of our first year management assessment for Sarbanes-Oxley Section 404 compliance. As a percentage of total revenue, general and administrative expense was approximately 15% for the nine months ended September 30, 2007 and 12% for the nine months ended September 30, 2006. The increase as a percentage of revenue is due to general and administrative expenses increasing while revenue decreased.

Interest Income, Net

Interest income, net of interest expense, remained relatively consistent at $185,000 for the three months ended September 30, 2007 compared to $189,000 for the same period in the prior year. Interest income, net of interest expense, was $578,000 for the nine months ended September 30, 2007 and $429,000 for the nine months ended September 30, 2006. The increase in interest income, net, for the nine month period primarily relates to higher investment rates of returns.

Other Income (Expense), Net

Other income, net, was $192,000 for the three months ended September 30, 2007, compared to a $46,000 loss for the same period in the prior year. Other income, net, was $349,000 and $314,000 for the nine months ended September 30, 2007 and 2006, respectively. The increase in other income, net, for each of the periods presented primarily relates to the change in market value of our foreign exchange derivative financial instruments which resulted in income of approximately $187,000 for the three months ended September 30, 2007 and an expense of $55,000 for the three months ended September 30, 2006. For the nine months ended September 30, 2007 and 2006 our foreign exchange derivative financial instruments resulted in income of approximately $306,000 and $294,000, respectively (See Note 4 in Notes to Condensed Consolidated Financial Statements for more information).

Income Taxes

Our tax benefit rate for the nine months ended September 30, 2007 was 28%, compared to a tax benefit rate of 18% for the nine months ended September 30, 2006. Although we were in a net income position in 2006, we recorded a tax benefit due to tax credits generated in our foreign operations. This benefit was primarily the result of a 10% research and development tax credit.

The effective tax rate differed from the U.S. statutory rate as we continued to provide a full valuation allowance for our net deferred tax assets at September 30, 2007 and September 30, 2006.

Net Income (Loss)

We reported net income of $698,000 and $175,000 for the three months ended September 30, 2007 and 2006, respectively. Basic and diluted earnings per share for the three months ended September 30, 2007 were $0.11 and $0.10, respectively. Both basic and diluted earnings per share for the three months ended September 30, 2006 were $0.03. The Company reported a net loss of $764,000 for the nine months ended September 30, 2007, as compared to a net income of $1.6 million for the nine months ended September 30, 2006. Basic loss per share for the nine months ended September 30, 2007 was ($0.13). Basic and diluted earnings per share for the nine months ended September 30, 2006 were $0.28 and $0.27, respectively.

LIQUIDITY AND CAPITAL RESOURCES

Consolidated Cash Flows

Cash and cash equivalents decreased $3.6 million for the nine months ended September 30, 2007 and increased $4.6 million for the same period in the prior year. Cash flows are impacted by operating, investing and financing activities.

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Operating Activities

Trends in cash flows from operating activities for the nine months ended September 30, 2007 and 2006 are generally similar to the trends in our earnings except for provision for uncollectible accounts and returns, provision for excess and obsolete inventories, depreciation and amortization and amortization of restricted stock. Cash used in operating activities totaled $2.2 million for the nine months ended September 30, 2007, compared to a net loss of $764,000. Provision for uncollectible accounts and returns increased slightly for the nine months ended September 30, 2007 compared to the same period in 2006. Provision for excess and obsolete inventories decreased $100,000 for the nine months ended September 30, 2007 compared to the same period in 2006. Depreciation and amortization increased $174,000 for the nine months ended September 30, 2007 compared to the same period in 2006. Amortization of restricted stock increased $50,000 for the nine months ended September 30, 2007, compared to the nine months ended September 30, 2006 (See Note 2 in Notes to Condensed Consolidated Financial Statements for more information on restricted stock).

Changes in assets and liabilities result primarily from the timing of production, sales, purchases and payments. Such changes in assets and liabilities generally tend to even out over time and result in trends in cash flows from operating activities generally reflecting earnings trends.

Investing Activities

Cash used in investing activities totaled $2.1 million for the nine months ended September 30, 2007 compared to cash provided by investing activities of $769,000 in the same period of the prior year. Additions to property and equipment and capitalized software were $1.2 million for the nine months ended September 30, 2007 compared to $634,000 for the nine months ended September 30, 2006. The additions for the nine months ended September 30, 2007 primarily related to our new enterprise management system and equipment purchases for our engineering function. The additions for the nine months ended September 30, 2006 primarily related to software and equipment purchases for our engineering and manufacturing functions. Purchases of marketable securities were $12.4 million and $10.3 million for the nine months ended September 30, 2007 and 2006, respectively. Proceeds from the sale of marketable securities decreased slightly to $11.5 million for the nine months ended September 30, 2007 compared to $11.7 million for the same period in 2006.

Financing Activities

Net cash provided by financing activities totaled $735,000 for the nine months ended September 30, 2007 compared to $392,000 for the nine months ended September 30, 2006. Net cash provided by financing activities for both periods presented related to proceeds from employees exercising stock options.

Commitments

Commitments

At September 30, 2007, we had no material commitments to purchase capital assets. However, planned capital expenditures for 2007 are estimated at approximately $1.7 million of which $500,000 remains, the majority of which relates to our investment in a new enterprise management system. The remaining planned purchases relate to engineering, manufacturing and general office equipment. Our significant long-term obligations as of September 30, 2007, are our operating leases on facilities and future debt payments related to our credit facility. To date, we have not paid any dividends and do not anticipate paying any dividends in 2007.

Off-Balance Sheet Arrangements

At September 30, 2007 we had two foreign exchange contracts outstanding to acquire 1.1 million Euros for each contract on specified dates during the next four months. At September 30, 2007, we carried a $241,000 asset on the balance sheet, classified in prepaid expenses and other current assets, related to the fair value of our outstanding foreign exchange contracts. There were three such contracts outstanding at December 31, 2006 classified as a $185,000 asset on the balance sheet and included in prepaid expenses and other current assets.

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Other

Management believes that cash generated from operations and borrowing availability under the revolving credit facility, together with cash on hand, will be sufficient to meet our liquidity needs for working capital, capital expenditures and debt service. To the extent that our actual operating results or other developments differ from our expectations, our liquidity could be adversely affected.

We periodically evaluate our liquidity requirements, alternative uses of capital, capital needs and available resources in view of, among other things, our capital expenditure requirements and estimated future operating cash flows. As a result of this process, we have in the past, and may in the future, seek to raise additional capital, refinance or restructure indebtedness, issue additional securities, repurchase shares of our common stock or take a combination of such steps to manage our liquidity and capital resources. In the normal course of business, we may review opportunities for acquisitions, joint ventures or other business combinations. In the event of any such transaction, we may consider using available cash, issuing additional equity securities or increasing our indebtedness or our subsidiaries’ indebtedness.

Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Quarterly Report on Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and other material included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Risk

The Company is exposed to adverse movements in foreign currency exchange rates because it conducts business on a global basis and in some cases in foreign currencies. The Company’s operations in France are measured in the local currency and converted into U.S. Dollars based on published exchange rates for the periods reported and are therefore subject to risk of exchange rate fluctuations. The Euro to U.S. Dollar translation accounted for charges of approximately $436,000 and $288,000 for the three months ended September 30, 2007, and 2006, respectively. The Euro to U.S. Dollar translation accounted for charges of approximately $1.3 million and $817,000 for the nine months ended September 30, 2007 and 2006, respectively.

In an attempt to mitigate the risk described above, the Company may enter into, from time to time, foreign exchange contracts to purchase a fixed amount of Euros on a fixed date in the future at a fixed rate determined at the contract date.  These derivative financial instruments do not meet the criteria to qualify as hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and therefore, any changes in the market value of these contracts are recognized as a gain or loss in the period of the change.  For the three months and nine months ended September 30, 2007, the Company recognized a gain of approximately $187,000 and $306,000 respectively related to these foreign exchange contracts. For the three months ended September 30, 2006 the Company recognized a loss of approximately $55,000 and for the nine months ended September 30, 2006, the Company recognized a gain of approximately $294,000 related to these foreign exchange contracts. At September 30, 2007, the Company had two foreign exchange contracts outstanding to acquire 1.1 million Euros for each contract on specified dates during the next four months. At September 30, 2007, the Company carried a $241,000 asset on the balance sheet, classified in prepaid expenses and other current assets, related to the fair value of its outstanding foreign exchange contracts. There were three such contracts outstanding at December 31, 2006 classified as a $185,000 asset on the balance sheet and included in prepaid expenses and other current assets.

Market Price Risk

We had no equity hedge contracts outstanding as of September 30, 2007 or December 31, 2006.

Interest Rate Risk

Our investments are subject to interest rate risk. Interest rate risk is the risk that our financial condition and results of operations could be adversely affected due to movements in interest rates. We invest our cash in a variety of interest-earning financial instruments, including bank time deposits, money market funds, and variable rate and fixed rate obligations of corporations and national governmental entities and agencies. Due to the demand nature of our money market funds and the short-term nature of our time deposits and debt securities portfolio, these assets

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are particularly sensitive to changes in interest rates. We manage this risk through investments with shorter-term maturities and varying maturity dates.

A hypothetical 50 basis point increase in interest rates would be expected to result in an approximate decrease of less than 1% in the fair value of our available-for-sale securities at September 30, 2007. This potential change is based on sensitivity analyses performed on our marketable securities at September 30, 2007. Actual results may differ materially. We estimate that the same hypothetical 50 basis point increase in interest rates would have resulted in an approximate decrease of less than 1% in the fair value of our available-for-sale securities at December 31, 2006.

Our credit facility bears interest at a variable rate tied to the London Interbank Offered Rate (LIBOR). The current interest rate on our credit facility is 6.25% (LIBOR + 1%). In an attempt to mitigate interest rate fluctuations, we from time to time may enter into agreements to lock the interest rate; our current agreement will expire on July 31, 2008. A hypothetical 100 basis point increase in LIBOR would increase annual interest expense on this credit facility by approximately $35,000.

Item 4. CONTROLS AND PROCEDURES

(a)

Evaluation of Disclosure Controls and Procedures. The Company’s management, under the supervision of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), performed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on that evaluation, the CEO and CFO concluded that the Company’s disclosure controls and procedures are effective, to give reasonable assurance that the information required to be disclosed by the Company in reports that it files under the Exchange Act is accumulated and communicated to management, including the CEO and CFO, to allow timely decisions regarding disclosure and that information is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC.

(b)

Changes in Internal Controls.  The Company maintains a system of internal controls that are designed to provide reasonable assurance that its books and records accurately reflect, in all material respects, the transactions of the Company and that its established policies and procedures are adhered to.  There were no changes to the Company’s internal controls or in other factors that could significantly affect the Company’s internal controls subsequent to the date of the evaluation by the Company’s CEO and CFO, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II
OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

None.

Item 1A. RISK FACTORS

There have been no material changes from the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

Item 3. DEFAULTS UPON SENIOR SECURITIES

None.

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Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

Item 5. OTHER INFORMATION

None.

Item 6. EXHIBITS

Exhibits

2 (a)	Stock Purchase Agreement, dated as of June 29, 1996, among Interphase Corporation, Synaptel and Philippe Oros, Xavier Sutter, Francois Lecerf, Schroder Ventures French Enterprise Fund LPI (USA), Schroder ventures French Enterprise Fund UKLP (UK) and Schroder Ventures Holding Limited (UK). (2)
3 (a)	Certificate of Incorporation of the registrant. (1)
3 (b)	Amendment to Articles of Incorporation of the registrant. (3)
3 (c)	Amended and Restated Bylaws of the registrant adopted on July 25, 2007. (5)
4 (a)	Rights Agreement dated as of December 7, 2000 by and between the Company and Computershare Investor Services, LLC as Rights Agent. (4)
10 (a)	Lease on Facility at Parkway Center, Phase I, Plano, Texas. (6)
10 (b)	Lease on Facility at 2105 Luna Road, Carrollton, Texas. (6)
10 (c)	Note and Credit Agreement between Interphase Corporation and Comerica Bank, including Amendment dated November 5, 2004. (7)
10 (d)	Employment Agreement with Gregory B. Kalush, dated March 12, 1999. *(9)
10 (e)	Employment, Confidentiality, and Non-Competition Agreement with Thomas N. Tipton, Jr., dated December 19, 2005. *(9)
10 (f)	Employment, Confidentiality, and Non-Competition Agreement with Randall E. McComas, dated February 15, 2002. *(9)
10 (g)	Employment Agreement with Deborah A. Shute, dated November 24, 1999. *(9)
10 (h)	Employment, Confidentiality, and Non-Competition Agreement with James W. Gragg, dated November 1, 2004. *(9)
10 (i)	Employment, Confidentiality, and Non-Competition Agreement with Prasad Kallur, dated May 23, 2005. *(9)
10 (j)	Interphase Corporation 2004 Long-Term Stock Incentive Plan *(8)
10 (k)	Employment, Confidentiality, and Non-Competition Agreement with Marc E. DeVinney, dated August 31, 2007. *(10)
31 (a)	Rule 13a-14(a)/15d-14(a) Certification. (11)
31 (b)	Rule 13a-14(a)/15d-14(a) Certification. (11)
32 (a)	Section 1350 Certification. (11)
32 (b)	Section 1350 Certification. (11)

(1)	Filed as an exhibit to Registration Statement No. 2-86523 on Form S-1 and incorporated herein by reference.
(2)	Filed as an exhibit to Report on Form 8-K on August 6, 1996, and incorporated herein by reference.
(3)	Filed as an exhibit to Report on Form 10-K for the year ended December 31, 1999, and incorporated herein by reference.
(4)	Filed as an exhibit to Form 8-K on January 9, 2001, and incorporated herein by reference.
(5)	Filed as an exhibit to Report on Form 8-K on July 31, 2007, and incorporated herein by reference.
(6)	Filed as an exhibit to Report on Form 10-Q for the quarter ended September 30, 2002, and incorporated herein by reference.
(7)	Filed as an exhibit to Report on Form 10-K for the year ended December 31, 2004, and incorporated herein by reference.
(8)	Filed as an exhibit to Schedule 14a on March 31, 2005 and incorporated herein by reference.
(9)	Filed as an exhibit to Report on Form 10-K for the year ended December 31, 2005 and incorporated herein by reference.
(10)	Filed as an exhibit to Report on Form 8-K on August 31, 2007, and incorporated herein by reference.
(11)	Filed herewith

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* Management contract or compensatory plan or arrangement

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	INTERPHASE CORPORATION (Registrant)
Date: November 9, 2007	By:	/s/ Thomas N. Tipton Jr.
		Thomas N. Tipton Jr.
		Chief Financial Officer, Vice President of Finance and Treasurer (Principal Financial and Accounting Officer)

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